raytoei (90.83)

2007 Portfolio Review and Comments

9

My real money portfolio returned 21.30% for the year 2007. My simple portfolio returns is measured by dividing 31st December closing balance by beginning of the year balance.

What went right this year

1. A good portfolio mix

Not entirely by design and more like a lucky coincidence, my portfolio was balanced by 1/3 Cash and short term investments, and with the remaining 2/3rds, it was split between heavy weight like MasterCard, Cola-Cola, Berkshire Hathaway, Western Union and Wrigley’s and faster moving but volatile small cap stocks like Taser, Buffalo Wild Wings and financial stocks.

Well, Cola-Cola and Berkshire Hathaway grew and grew this year and in late 2007, investors flocked to WU as well. Most interesting of all was MasterCard; I bought at $45 and exited at $133 in May this year. This no doubt contributed significantly to portfolio gains, and even whiles my small-caps and financial stock swoon, these large cap stocks held well.

2. In July, I bet a third of the portfolio on the going-private transaction of Chicago Tribune (TRB). I was counting on Sam Zell’s investment prowess and tenacity would bring closure to the transaction. It was a right bet, but a scary one as the general sub-prime fears made Tribune a good poster-boy for short-sellers. My gain from Tribune was 18.2%, however, the spread was as wide as 30% during the terrible months of August.

Two things I learnt from the Tribune deal were

(a) There are a lot of regurgitation when it comes to news, especially bad news that feed on investor fears. And many times the news is poorly researched and many reporters take price action as a leading indicator, for example, when the spread was 20+%, the reports came out and concluded that because the spread was so wide, Tribune was doomed. Surprisingly, the only reports that took a rational and balanced view came from sell-side analysts, who perhaps were well versed in M&A financing and could put an accurate pulse in the transaction.

(b) William Pound wrote in Fortune’s Formula that one of the reasons why funds blow up is because of “Over betting”, this takes in the form of leverage or a lack of diversification. The error of my calculation was that I calculated positive Expected Returns from the Tribune deal hence I bet the farm. But expected returns looks at average returns in the long run, so if I have an infinite number of TRB deals and assuming that I calculated the odds correctly, I would expect the average returns to approximate my Expected Returns. But putting all the bankroll (available cash) into a single stock, in hindsight might not have been the wisest move. In my later re-calculation using the Kelly Criterion, the percentage to put into TRB fell in between 16.7% to 30% of the bankroll (Gulp!)

My dumbest investment for 2007

It definitely has to be Image Entertainment (DISK). I bought this last week; the thesis was that the company DISK was going to be bought by a company owned by film producer David Bergstein. But the transaction closure kept shifting, from early November to December to currently mid-Jan. Because of the investor sell-off, I jumped in. I knew that the transaction would ultimately go through since there were several signs that pointed to eventual closure.(2m deposit + acquiring company’s intention to buy back shares in the open market), but I simply did not have the confidence that I would get my money back in a timely manner (at best a 50% chance). I hastily exited late last week and lost about 2% on DISK’s spread, but I definitely slept better.

What to look forward to in 2008

Besides event-driven stocks like Midwest Air and Alliance Data Systems, I do not really expect to modify my portfolio. My worst performing stocks in 2007, namely small-caps, financials have a chance to do well in 2008 and the only speculative stock in my stable is GGC. Georgia Gulf at this point is cheap but unfortunately it is not safe. The thing going for it is that the management is a lean operator with good operating history.

The other stocks are relatively high quality and I simply bought too soon (maybe way too soon). The crux of the question for my 2008 portfolio should be: How rich a valuation should Coca-cola, Microsoft and (shudder) Berkshire Hathaway need to get before I sell it and invest the proceeds into my 2007 loser stocks ?

** Please note that the gains are gotten since the individual stock purchase and not just for 2007. For example, while BWLD gained 61.22% since it was purchased in 2005/2006, it actually lost 12.97% for the whole 2007.

hold onto your WU stock. I loaded up on in my real portfolio and am buying as many call options as I can. Hold the Berkshire also. Do you have any regret selling the the MA at 133? 21% is not a bad year at all though